Determining the Collateral Value of a Secured Claim

Knowing Collateral Value Helps Determine the Creditor’s Rights Under a Plan

Why do creditors need to know the collateral value of a secured claim?

The answer here seems quite obvious when a secured creditor is under-secured — that is, when the value of its claim exceeds the value of the collateral securing it. In that case, the absolute priority rule of the Bankruptcy Code dictates that the unsecured portion of the claim be treated as a lower priority. Generally, this means the unsecured portion is treated the same as other unsecured claims.

When it comes to over-secured claims, however, we have a totally different issue. In these cases, we run into the question of how much post-petition interest the estate has to pay the secured creditor on top of the principal.

What Happens When Collateral Value Shows the Claim Is Over-Secured?

You may be wondering…post-petition interest? Isn’t that only available when a debtor is flush enough to pay more than 100 cents on the dollar to its pre-petition claimants? This is true for most unsecured claims. Secured claims, however, can be entitled to post-petition interest even when unsecured claimants are impaired.

This is precisely what happens when the collateral value of the property securing the claim exceeds the value of the claim. We’re not talking chicken feed here; the collateral value could add up to be quite a lot of money for a senior secured creditor. That increased payout to the secured claimant can thus have a huge negative impact on a smaller pool of general unsecured creditors. As such, it’s an issue that needs to be carefully considered.

The secured claimant is also entitled to compound interest, and even additional fees, costs, and charges, if the underlying loan documents provided for such. This is expressly stated in the Bankruptcy Code, 11 U.S.C. Section 506(b):

“To the extent that an allowed secured claim is secured by property the value of which, after any recovery under subsection (c) of this section, is greater than the amount of such claim, there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement or State statute under which such claim arose.”

Proving a Claim Is Over-Secured

Calculating interest is more art than science. The calendar date and the method used for determining collateral value are both subjective criteria that are shaped by argument and debate.

Before a secured creditor can rightfully demand all the applicable post-petition interest, fees, costs, and charges, it must prove that it was over-secured, as of the date it alleges (often the petition date).

The value of assets can change over time. Let’s suppose the value of the collateral is believed to have gone down since the petition date. In this case, the date that a secured creditor may want to use for valuation is likely not the same date the debtor or parties of opposing interests may want to use. In contrast, let’s suppose the value of the collateral is known to have gone up since the petition date. Those interested in minimizing the extra payment on the claim will surely argue that the interest is only due from the date they allege the value to have exceeded the claim.

Unlike the Petition Date or other dates leading up to an asset sale, the value of the collateral, which is often comprised of substantially all of the debtor company’s assets, for an individual or consortium of senior secured lenders cannot be as easily determined.

This doesn’t mean the value the market assigned to those assets upon the sale only became applicable on that sale date. In the case of SW Boston Hotel Venture, LLC, 748 F.3d 393 (1st Cir. 2014), the First Circuit approved the bankruptcy court’s use of a flexible approach to determining the date of when a secured creditor is over-secured.

Valuation Methodologies: Value in Use vs Fair Market Value

Another area of contention is the valuation methodology itself. There are two primary methods used here:

1. Value in Use: The value that certain assets have to a certain buyer or bidder for its own peculiar reasons.
2. Fair Market Value: Better referred to as the general market rule. This is the value that the general market would pay, especially actual bidders and purchasers involved in the sale process.

These terms are not explicitly defined in the Bankruptcy Code. Having a requirement in a miscellaneous controlling document that a ‘fair market value’ for an asset will be determined is not specific enough to bind a bankruptcy court to use the latter.

It’s important to remember that ‘value in use’ is a well-respected methodology. Depending on the circumstances, it may be the more appropriate one to use. This method can be supported with compelling arguments when the collateral valuation is relied upon in determining a lender’s pro-rata share of the proceeds of an asset sale.

Time and Valuation Are Key Considerations

When considering asset valuations, it is crucial to look for specifics on valuation and timing in the controlling documents of the case.  Debtors or other interested parties may try to propose something for bankruptcy court approval that is against your interests.

When these details have not been specified, creditors are left with a large area of wiggle room that could produce less desired results. At the very least, having these details specified presents opportunities to argue for an alternate treatment that may yield a more favorable outcome.

We think you’ll also like:

1. Common Mistakes in Drafting Collateral Descriptions
2. What Constitutes the ‘Legal Rate’ in a Solvent Debtor Bankruptcy Case?
3. Lender vs Debtor on the Payment of Post-Petition Interest

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Defending Against Bankruptcy Avoidance Actions
2. The Nuts and Bolts of a Chapter 11 Plan
3. Selecting the Right Valuation Expert

This is an updated version of an article published on September 14, 2015 and updated on March 11, 2024.]

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